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The Good Side of Recessions

Recessions get a bad rep. It’s perfectly understandably why: recessions suck. No one likes to lose their job, or have to budget. Recessions are messy, ugly, and frightening. But they can also be good. To understand why, it is important to understand what a recession is.

A recession is more than just a country-wide thing. Firms and individuals undergo recessions fairly frequently. All a recession is is when economic activity (production and/or consumption) drops. This could be due to the loss of a job, or the ending of a product line, or even a career choice. What is typically known as a recession is when these individualized instances aggregate.

Recessions are typically an indication of misapplied resources. Remember that the goal of all economic activity is to produce value. Without value, there can be no exchange, and no wealth is generated. Therefore, any activity that doesn’t generate wealth contains therein misapplied resources. Recessions will occur to encourage the owners of the resources to stop applying them to the non-valued ventures. Take, for example, the fairly recent bankruptcy of Kodak, a film and imaging company. In a time of nearly ubiquitous digital cameras and digital photo storage, the concept of film became obsolete and Kodak stopped offering value. As such, it went into a recession. The resources at Kodak’s command are now freed up to pursue other more valuable ventures. In other words, Kodak’s recession actually stands to benefit the economy.

This is the big lesson here: recessions drive out unproductive and non-valued products and free up resources for more productive uses. They do suck, but it’s the way the economy heals. Political policies designed to hinder recessions actually hinder economic growth by preventing the reallocation of unproductive resources. For example, if a (politically connected) industry is facing recession, a typical response is to bail them out. This just encourages the bailed out firms to keep doing what they were doing; they felt no costs and thus had no incentive to reallocate their resources (it also sets up a dangerous precedence, but that’s for another post). When we get sick, we run a fever and may vomit. It sucks, but it’s how the body heals. Recessions are the same way.

Economic actors should always strive to produce value, but if they are faced with a recession, the best thing to do is to recognize it and reallocate.

I wish they taught us this angle in school. The standard view I’ve gotten in undergrad is that recessions are an unnecessary free-market phenomenon that can be smoothed out by fiscal and monetary “tools.”

But you’re correct, it’s an adjustment/healing process that the economy has to go through in order to get back to sustainable levels of output and consumption.

Just curious, what’s your take on general business cycles? You noted that firms and families go through recessions quite frequently, but what do you think causes entire industries to go through a bust simultaneously? I find the Austrian explanation rather compelling, but would love to hear your view…

Good question. I tend to agree with the Austrian idea of malinvestment and malconsumption driving recessions. Sometimes these malinvestments can be driven by government (such as the 2008 housing bust). Sometimes they can be driven by (for lack of a better word) irrational excitement (such as the current oil bust)

The Austrian explanation is indeed compelling. If you don’t mind my asking, how were you exposed to that viewpoint? I don’t think it’s commonly taught in schools, and I, like most people I’ve talked to, just kind of tripped on the Austrian authors while looking for something else.

Ron Paul has had a tremendous impact on young people, and it’s folks like you and Jon Murphy that gives me hope for the future. I just hope he (and I) live long enough to see some results from his tremendous efforts. to bring the leviathan to its knees.

I like the analogy of the brush building up in the forest that needs to burn every once in a while to rejuvenate the forest (certain forest types, not all). But if that is suppressed then brush builds up and when it eventually does burn the fire is much more destructive, burning the large established trees that normally wouldn’t be significantly harmed. You can, of course, make the appropriate connections to our managed economy with suppressed recessions, etc.

There are other similar analogies that refer to the ecology of an ecosystem, which I think are quite apt as the economy is an emergent, self organizing, complex system that is inevitably harmed when we try to manage it or plan it.